Is Average Good Enough?

Averages are everywhere, everything is measured against the ‘average’ but what does ‘average’ actually mean for the average man in the street?

If you are weighing up taking an umbrella as you leave your home, the weather report will show the average likelihood of rain in an area. When you are watching football, tennis, or cricket, the bottom of the screen is usually filled with graphics showing averages of possession, or first serves made, or runs scored. Do you count your daily ‘steps’, trying to reach that 10,000 average (like 76% of British people according to a recent survey from Perkbox).

Whilst averages are a useful way to simplify things, they are not always useful (for example, no-one in the UK has exactly 1.9 children).

And sometimes, they’re worse than useless, they’re misleading …

Famously, US Air Force Lt. Gilbert Daniels found this while trying to design a cockpit for the average US fighter pilot in the 1950’s. More than 4,000 pilots had 10 key measurements taken (chest/legs/arms etc). Not one of the pilots matched the overall average. Someone might have average arm-span, but longer or shorter legs, or a wider or thinner chest. The average pilot did not exist!

And in the investment world, we see the same thing. The average year in markets does not really exist.

According to the statisticians, the average return of the S&P 500 over the last 42 years is 10%. But only once in those 44 years has the actual annual return been 10% (in 2016)!

Only three other years are even within 2%; there are huge positive years, uninspiring sideways years, and terrifying negative years.

When setting our expectations, the chart below is a good reminder that the average annual return is not at all common.

Source: Macrobond/7IM

Cover image: Freepik.com